Rising Mortgage Delinquencies in Major Cities Point to Looming Liquidity Issues

What happens when you have a high net worth, but your wealth is all tied up in assets? It’s like trying to buy a snack from a vending machine, but all you have is a credit card. You may be good for the money, but the medium just isn’t right. It’s a situation may Canadian real estate investors are running into, and it has a name: Low liquidity.

Low liquidity is a problem for many reasons. The biggest, is lack of accessibility to your wealth. You may have a net worth of $1.2M based on a collection of real estate assets, stock holdings and savings… but, if only $12,000 of that is in cash, you really only have access to one percent of your wealth. In a transaction situation that requires you to tap into more of your wealth, you’re simply not going to have the means unless you liquidate fast. And that brings about even more problems!

It’s safe to say that having assets like real estate is absolutely a good thing, but investors need to pay mind to how much of their wealth is tied up, versus how much is liquid and available.

Liquidity is becoming an issue

Until recently, the Canadian real estate market has been a hotbed of activity. Not only has property been readily available, it’s been easy to afford thanks to low interest rates and accessible mortgage programs. These variables and more have created a feeding frenzy that many investors have thrown money into. Unfortunately, many didn’t stop to think about liquidity—they only saw opportunity.

Now that the housing market has cooled a bit and interest rates are beginning to rise, many investors are starting to encounter trouble. It’s not as easy to sell a flipped house or unload a rental, which means wealth is tied up in these properties. Moreover, investors with short-term strategies may be left holding property they didn’t intend on keeping for more than a few months. And while it’s great to have these assets, most would rather have the liquidity.

Recent reports issued by the Canada Mortgage and Housing Corporation (CMHC) show mortgage delinquencies climbing—specifically among the population with high-value mortgages. Quite simply, this means too many investors have money tied up and not enough liquidity to make good on the mortgages they’ve taken out!

Beyond personal liquidity

There are actually two types of liquidity at work in the Canadian real estate market: Personal liquidity and market liquidity. And while personal liquidity is likely the cause of delinquent mortgage payments, market liquidity is the reason behind problems with personal liquidity.

As mentioned, the market is cooling off. This means housing demand is waning while supply is stable or growing. Those holding real estate can’t find buyers due to market forced weighing against them. In this way, there’s a general lack of market liquidity, which is bearing down on personal liquidity.

What do delinquencies tell us?

At their most basic level, rising mortgage delinquencies tell us that people simply aren’t paying their mortgages. But it goes beyond that.

Mortgage delinquencies are recorded after 60 days, which means individuals have roughly two full months to make a payment. Delinquencies tell us that not only are payments not being made, homeowners are having issues unloading homes they can’t pay for. Consider the options for someone paying their mortgage:

•Find the money to pay the home within the 60-day window to avoid delinquency.

•Sell the home within 60 days to a buyer who can assume the mortgage payments.

•Borrow securely from an additional source to make payments on the mortgage.

It’s only after a mortgage holder exhausts these options that a mortgage becomes delinquent. Unfortunately, all of them are invalidated by liquidity issues:

•No liquid funds means you can’t pay your mortgage outright.

•Poor market liquidity means there’s no demand for your home.

•Lack of available capital or collateral means you can’t secure a loan.

In this way, delinquencies paint us a picture of much more than people who can’t afford their mortgages—they give us insight into liquidity problems at both the personal and market levels.

A look at the numbers

The numbers behind the reported rise in mortgage delinquencies point overwhelmingly at burdensome mortgages likely held by investors who didn’t take their own liquidity into consideration. Take a look at a few figures, courtesy of Equifax, CMHC and Better Dwelling:

•In Toronto, mortgages delinquencies on $400k and larger are up 28.57% from the previous year. These homes are much harder to sell due to their price point, which means they were already susceptible to liquidity issues.

•Toronto mortgages delinquencies for originations $100k and under are up 30%. These mortgages likely represent distressed property buyers or flippers who planned on unloading a property soon, but who have been forced to hold due to market conditions.

•The numbers for Vancouver run parallel to Toronto. Mortgage delinquencies above $400k rose 11.11%, while loans $100k and smaller are up 13.33% from their all-time lows.

•For both cities, mortgages between $100k and $300k have remained relatively flat, which signal the segment of total mortgages most likely occupied by non-investors. These mortgages are likely held by individuals with standard liquidity, who aren’t as vested as real estate investors.

These figures don’t add up to a definite conclusion, but they certainly cast property investors into questionable light as the typical holders of both upper-tier and lower-tier mortgages.

Fixing liquidity issues

Despite liquidity issues, there are ways for real estate investors to get themselves out of a pinch if they’re left holding a property they planned on cashing in for liquid cash.

For starters, transitioning a flipping strategy to a hold-and-rent strategy is the quickest way to generate cash flow. A rent-to-own plan is even better, since it can attract more responsible tenants and build in an eventual sale for the current property owner. Also viable is turning the property into a vacation rental by leveraging a platform like Airbnb.

If liquidity has become a real problem and a sale is imperative, there are a few unsavory options that may erase your intended profits, but still help you break even or even earn a minor profit.

•First, is bundling properties. Selling several properties to a more liquid investor can help you unburden yourself of a lease and help you avoid being cash-poor for an extended period. Keep in mind, this only works if you have properties with more collateral to offset properties you’re overleveraged on.

•Auctions are another not-so-great way to liquidate a property, but nonetheless effective in helping you keep your head above water. Many auctioneers will actually help you get the best value for your property because they receive a portion of the sale.

•Have an in with a reputable real estate agent? Making one big push to sell your property can help you find a buyer in a market that’s cooling. Some investors or home buyers wait until the ‘offseason’ to shop for homes and don’t mind paying a premium on the right property. If time is on your side, gear up for a marketing push.

There are also for sale by owner (FSBO) options to consider, but they’re not always advised when you’re dealing with over-leveraged property.

Always consider liquidity

If the recent data about mortgage delinquencies is any indication, liquidity is a big problem in the Canadian real estate scene right now. And it’s likely to become a bigger one as time goes on. It’s a lesson for any real estate investor, new or seasoned alike: Always consider liquidity and remember that the market can change in an instant!